What Is Yield Farming? 🌾

What Is Yield Farming? 🌾

Decentralized finance (DeFi) 🚀 has experienced explosive growth in recent years, with the total value locked (TVL) reaching over a quarter of a trillion dollars 💰. The flourishing DeFi ecosystem is a network of trust-minimized financial apps that anyone with an internet connection 🌐 can access.

Fueling this growth is the rapid pace of development and innovation within DeFi. 🌎 Smart contract developers have been building, iterating, and deploying new decentralized applications at an unprecedented speed ⚡. The permissionless nature of DeFi’scomposability allows for innovative financial primitives that weren’t possible due to the inefficiencies and risks in traditional finance 💱. One of these breakthroughs is yield farming, also known as liquidity mining 🌱.

In this article, we’ll explore the value of yield farming for DeFi protocols, discuss its benefits and risks 📈📉, and look at how projects have successfully boosted liquidity and token distribution through increasingly sophisticated yield farming schemes 💹.

What Is Yield Farming (Liquidity Mining)? 🌾💧

Yield farming, or liquidity mining, is a new DeFi financial primitive that rewards users for providing liquidity or other value-added services to a decentralized app's ecosystem 🔄. In essence, yield farming incentives reward users who bring value to an on-chain protocol 💎. Yield farmers (depositors) earn rewards proportional to their deposits, usually in the app’s native token, which increases their Annual Percentage Return (APR) 📊.

Yield farming usually aims to achieve two main goals:

• Bootstrapping liquidity 💧—Incentivizes users to lock up liquidity in a DeFi app, which grows the TVL 📈 and strengthens the ecosystem. For example, when a DEX has more liquidity, it reduces slippage for users and can stabilize token prices 🏦. Additionally, when the ecosystem offers a superior product, it can attract even more demand 👥.

• Distributing tokens 🪙—Promotes fair distribution of a DeFi app's native token by rewarding users who deposit their funds. Fair token distribution fosters greater participation in decentralized governance processes since more users have a stake 🎉.

These token rewards are in addition to any built-in revenue streams a protocol generates, such as trading fees on a DEX or interest from lending protocols 💼. Some projects even reward yield farming for activities like community support, marketing, or developer contributions 🎨👨‍💻.

Different DeFi protocols use yield farming in various ways based on their unique objectives, often aiming to achieve one or both of these goals. Yield farming has helped countless projects grow quickly, attracting millions or billions in user funds 💸🌍.

How Does Yield Farming Work? 🔄

Protocols following the liquidity mining model range from DEXs to money markets, yield aggregators, and more 🌐💹. These projects benefit from a network of early users who actively bootstrap liquidity and participate in governance. Early implementations of yield farming focused on directly increasing liquidity for specific assets 💸.

Yield Farming Implementations and Strategies 📈

One of the earliest pioneers in yield farming was Synthetix 💎, a synthetic asset protocol that uses Chainbased Price Feeds 🔗. In 2019, Synthetix introduced a liquidity mining mechanism to reward sETH/ETH liquidity providers on Uniswap 🌊. Those who staked their sETH/ETH liquidity pool tokens on Uniswap earned SNX tokens proportional to their provided liquidity 🪙.

This allowed liquidity providers to earn additional yield on top of Uniswap trading fees (offsetting impermanent loss 📉), while also making it easier for new traders to enter the Synthetix ecosystem 🏦. Later, Synthetix’s yield farming program started offering SNX rewards to users who deposited sUSD (its stablecoin) on Curve Finance 📊, along with other popular stablecoins 💵.

Yield Farming vs. Staking 🌾 vs. 🔒

Yield farming is often compared to staking 🔒. Staking typically involves locking up tokens to secure a blockchain network or smart contract. In DeFi, it can also refer to providing liquidity, earning yield rewards, and participating in governance 🗳️. Although yield farming and staking often refer to similar actions (depositing tokens in a smart contract), they can differ significantly 🌈. Protocols may refer to depositing into a liquidity pool as “staking,” but yield farming also includes strategies that generate returns by connecting multiple protocols 🤝.

Automated Yield-Generating Strategies 🤖📈

Yield farming has led to the creation of automated strategies within DeFi 💡. Developers have crafted sophisticated strategies that cycle deposits across multiple protocols to maximize returns, often managed by yield aggregators that offer these strategies through “vaults” 🏦. In exchange for a performance fee (a share of the profits), users can access higher yields without having to understand the complexities of the underlying strategies 🌐. This can also be a gas-efficient way to earn yield, making DeFi more accessible to a broader audience 🌍.

Yield farming's evolution has created new terms within DeFi: “pool 1” and “pool 2” 🌊. “Pool 1” allows staking of pre-existing tokens with liquid markets (e.g., ETH, stablecoins💸), while “pool 2” requires exposure to the yield farming token itself 🪙, directly bootstrapping its liquidity.

Yield farming and liquidity mining continue to play a significant role in the DeFi landscape, offering innovative ways to grow ecosystems, incentivize user participation, and distribute governance tokens 🌐📈. As DeFi evolves, yield farming strategies will likely continue to adapt, drawing in more users and funds 🚀.